What Are An Angel Investor And A Venture Capitalist? Angel Investors vs. Venture Capitalists

An angel investor is a wealthy individual who uses their own money to invest in small businesses. A venture capitalist, on the other hand, is an individual or firm that makes a similar investment using money pooled from other companies, corporations, and pension funds. Venture capitalists do not invest their own money. In many cases, venture capitalists need angel investors to understand businesses with great potential from a very early stage.

Understanding angel investors

The angel investor provides capital to an early-stage start-up in exchange for equity or convertible debt. Some angel investors will also provide mentorship and advice, while others form syndicates and collectively invest in businesses.

Most angel investors are accredited by the Securities Exchange Commission (SEC) provided they meet one of two conditions:

  • Their annual income was at least $200,000 for the past two years. This increases to $300,000 if the individual files taxes with a spouse.
  • They have a minimum net worth of $1 million, excluding the value of their primary residence.

When Amazon was a startup, for example, Jeff Bezos received $300,000 from his parents and a further $1 million from twenty wealthy investors who contributed $50,000 each.

Note that angel investors serve as the bridge between the initial financing needs of a startup and more significant capital requirements as it grows. They are focused on helping the entrepreneur build their business and, at least initially, are less concerned with making a profit.

Angel investor advantages

Angel investors tend to be less risk-averse than traditional financial institutions. In most cases, they do not expect to be paid back if the venture they are financing fails.

Entrepreneurs also benefit from the wealth of industry knowledge and experience that many such investors bring to the table.

Understanding venture capitalists

Venture capitalists are employees of venture capital firms that invest using money from other companies, large corporations, and pension funds.

While angel investors are a critical early source of funding, venture capitalists provide funding for more established startups to help them transition through various growth stages into mergers, acquisitions, or IPOs.

Venture capitalist investment also tends to be more significant, with a single investment typically in the range of $3-5 million and lasting around a decade. In return, venture capitalists expect to be involved in operations and may request a seat on the board of directors.

In 2005, Facebook founder Mark Zuckerberg received a Series A funding round from venture capitalists worth $12.7 million.

Venture capital advantages

Venture capital funding is ideal for businesses that want to scale quickly. Like angel investment, there is generally no expectation that the money is paid back if the business fails.

Some venture capitalists are also well connected. In other words, they have a vast network of professional contacts that the startup can access to secure additional funding or recruit experienced talent.

Key takeaways:

  • An angel investor is a wealthy, accredited individual who uses their own money to invest in small businesses. A venture capitalist is an individual or firm that invests the money of other companies, corporations, and pension funds.
  • Angel investors provide capital to early-stage start-ups in exchange for equity or convertible debt. They may also provide mentorship and play a critical role in sustaining the operations of early-stage startups. 
  • Venture capitalists invest significant sums of money over longer timeframes to help startups undertake mergers, acquisitions, or IPOs. In exchange, many venture capital firms request a seat on the startup’s board of directors.

Connected Business Frameworks

Balance Sheet

The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).

Income Statement

The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at a fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).

Cash Flows

The cash flow statement is the third main financial statement, together with an income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.

Finanial Structure Modeling

In corporate finance, the financial structure is how corporations finance their assets (usually either through debt or equity). For the sake of reverse engineering businesses, we want to look at three critical elements to determine the model used to sustain its assets: cost structure, profitability, and cash flow generation.

Tech Modeling

A tech business model is made of four main components: value model (value propositions, missionvision), technological model (R&D management), distribution model (sales and marketing organizational structure), and financial model (revenue modeling, cost structure, profitability and cash generation/management). Those elements coming together can serve as the basis to build a solid tech business model.

Read Next: Income StatementBalance SheetCash Flow Statement, Financial StructureWACCCAPM.

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